The Chinese Property bubble is only growing and there is little the Government can do, argues one big bank

Despite the risks posed to China’s financial system by the country’s housing market, policymakers are likely to tolerate the bubble rather than introducing further measures to cool the market, that’s the key takeaway from a Deutsche Bank special report on China’s property market. China’s property market has become a key driver of growth and fiscal expansion in recent years, and as a result, policymakers are unlikely to move to constrict this vital pillar of the economy.

Indeed, according to Deutsche’s analysts Zhiwei Zhang and Li Zeng, China’s booming property market has created a massive wealth effect boosting household wealth in 37 tier 1 and tier 2 cities by RMB24 trillion, almost twice the disposable income of residents.

Authorities Cannot Risk Popping The Chinese Property bubble

This wealth effect may be helping to sustain consumption within China, despite slowing income growth. And this is why the government may not decide to pop the bubble. The wealth effect leads to lower saving, boosting demand for goods and services both domestically and internationally. According to Deutsche’s figures,

Chinese oversea travel expenditure reached 3.1% of GDP, vs. 2.2% in 2015, and the overall service trade deficit offset more than half of the goods trade surplus.

If the market cools, it may also result in a collapse in tax revenue. The property and construction sectors accounted for 33% and 15% of local government tax revenue growth respectively between 2010 and 2015. In 2015, these two sectors accounted for 43% of the local administration tax revenue compared to just 11% from manufacturing, arguably China’s largest industrial sector. The total land sale revenue that went into local governments’ extra-budgetary funds likely reached RMB3.1 trillion in 2015, equivalent to 49% of tax revenue.

Chinese Property bubble

It’s not just tax revenues that would suffer if the housing market started to cool. Households have poured their money into the housing market over the past 12 months. Mortgage loans accounted for 51% of new bank loans in the second half of 2016, compared to 31% in the first half of the year. If demand for mortgages collapsed banks would find themselves struggling to meet lending criteria and if prices went into reverse, there’s no telling how damaging rising mortgage defaults could be to China’s financial system.

As Chinese economic data is highly suspect at the best of times, it’s difficult to tell how much of an impact falling property prices would have on the country as a whole. However, what is clear is the sheer size of the property bubble. For example, the average property price in Shanghai appreciated from RMB36,935 to RMB45,847 per square meter during 2016, a gain of 24%. As mentioned above, the wealth effect from this bubble is becoming too big to ignore. Using Shanghai as an example Deutsche’s analysts point out that in this region alone the average Shanghai resident has experienced a property wealth increase of RMB161307, almost three times Shanghai’s per capita disposable income. In 18 of China’s 37 largest cities the ratio between property wealth increase in disposable income was above 1, and for nine cities the ratio was above 2.

As China’s economic growth slows, policymakers may be more than willing to let this bubble continue to inspire consumer spending growth and keep construction sector activity levels high.

The analysts end off the note stating:

It is hard to forecast the peak of a property bubble, but we can think about constraints that may trigger its deflation.